Why is cess charged?

A cess is basically a tax that the government collects for a specific purpose. The revenue generated from this tax is to be utilized solely for the purpose for which it has been created and collected and not for any other purpose. This earmarked tax can only be implemented after Parliament passes legislation clearly outlining the purpose of raising the funds. Normally, the union government is required to share tax revenue with state governments, but in the case of cess, Article 270 of the Constitution of India provides that the cess revenue imposed for specific purposes under any law made by the Parliament, can be excluded from the divisible pool of taxes that is required to be shared with the state governments. There are various avenues for the Union government to generate revenue like direct taxes, indirect taxes, surcharges, and cess. The revenue generated from direct taxes like the Goods and Services Tax (GST) and direct taxes like income tax can be utilized by the government in any mode that serves the public interest, but the cess revenue cannot be spent in any manner but for the specific purpose for which it is earmarked. But cesses are typically temporary, and the government can introduce and withdraw the cess at any time as per the evolving economic and social needs of the country. They serve as tools to achieve specific policy objectives and ensure financial stability for important government projects and initiatives.

Origin of cess and the impact of GST on cess

According to a report submitted to the fifteenth finance commission, the concept of cess has been in practice in India since 1944, with the first cess being levied on matches. After independence, the focus of levying cess was on the development of specific industries like textiles, coffee, etc. Later, the focus shifted to the welfare of laborers, which led to the introduction of the factory workers welfare cess in the 1980s and the coal mines labor welfare cess in the 1970s. The introduction of GST led to the removal of many cesses and at present, the number of cesses has reduced considerably.

Why is cess charged?

In India cess is charged for specific purposes to fund particular projects or initiatives that the government feels are essential. The main reasons why cess is charged are:

• Fund specific projects

Some projects require dedicated financial resources. For example, healthcare, education, infrastructure development, environmental conservation, etc. Cesses are very good avenues to source funds to meet specific socio-economic goals. The revenue from cess is not required to be shared with state governments as cesses are excluded from the divisible pool of tax revenues.

• Earmarked provides reliable funding

Some projects and initiatives need special attention and are important for the protection and progress of the people of the country. Earmarking tax revenue provides a reliable and predictable source of funding. It prevents the funds from being spent for other purposes. Hence, there is consistency in the treatment of cess taxes.

• Change of behavior

Sometimes cesses are imposed to influence consumer behavior or discourage certain habits. For example, cesses may be levied on tobacco products to discourage smoking habits due to their adverse effects on people’s health or on luxury goods to limit consumption.

• Emergency situations

During natural calamities like floods, earthquakes may cause an urgent need of funds for relief and rehabilitation. Cess provides a quick and efficient mode of revenue collection for the government. It is also easier for the government to correlate collection and expenditure when they know the purpose and the beneficiaries.

• Easier to incorporate

Cesses are easier to incorporate than taxes. They can be directly utilized for specific purposes without complicated changes in the tax structure or tax framework. It is also easier to modify and abolish the cesses when the purpose is accomplished.

• Fulfilling social and economic goals

Cesses may be imposed to fulfill social and economic goals such as promoting renewable energy or supporting marginalized communities. Cesses can be very useful in promoting the growth of industries, labor welfare programs, and the general welfare of the people of our country.

• Build credibility and trust in the taxpayers

Cesses can help build credibility and trust when the government demonstrates that the tax collected is spent for the purpose for which it was intended. This motivates people to pay their taxes promptly. Taxpayers also feel good to have contributed to bettering their country and countrymen.

• Policy and decision making

As cesses are earmarked for specific purposes, they provide better information on the amounts collected and spent, which helps policymakers plan and implement better tax systems.

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http://Six Years of GST: Compensation Cess Still Needs to be Sorted Out

Drawbacks of cess

• Need based allocation

In budgetary allocation, specific sums are allocated based on estimated needs, while the indefinite allocation in cess will not allow adjusting allocations depending on needs whenever they arise. It will cause problems when the needs are urgent and there is lack of available funds.

• Inflationary forces

As the cesses are decided in advance, during usage of the funds, inflationary forces may cause deficit, and the government may still have to depend on additional allocations from other sources.

• Additional budgetary allocations

Earmarked funds like cesses cannot avoid additional budgetary allocations. For example, the primary education cess now modified as the health and education cess does not eliminate the need for budgetary allocations for various health and education initiatives.

• Misallocation of funds

Locking-in funds for specific purposes may lead to misallocation of resources. Some purposes may receive excessively disproportionate amounts, while others do not get the necessary attention and support.

Contrasting cess and surcharge

Article 271 of the Constitution describes surcharge as ‘an increase in duties or taxes intended for the purposes of the Union government’. As surcharge is essentially a tax, it is not intended for an end purpose, undertaken at the time of collection. These purposes mean the union government can use the revenue for any public purpose it deems fit. Whereas cess under Article 270 of the Constitution dealing with cess taxes deals with the specific purpose defined and specified by the cess legislation. The cess proceeds cannot be used for any public purpose but only for the stipulated purpose.

Also read

Understanding Cess in GST with Examples

GST compensation cess

In direct taxes, the taxpayer pays the cess that is calculated and paid as a part of the total tax. In the case of cess on indirect taxes like GST the producer, manufacturers, traders, and service providers of the goods and services must collect and remit the cess along with the GST to the government. Eventually, the consumer pays the price as it is added to the cost of the goods and services.

Why was the GST compensation cess introduced?

When GST was implemented in India in 2017, the government assured compensation to the state governments for the revenue shortfall due to the subsuming of taxes such as VAT, etc., for five years. Consequently, the government implemented the GST compensation Act of 2017 to impose the compensation cess. The GST compensation cess is applicable on certain specific goods like tobacco, cigarettes, hookah, aerated water, high-end motorcycles, aircraft, yachts, and motor cars. All taxable persons supplying the notified goods are liable to collect and remit the GST compensation cess. It is important for businesses to understand the implications of the GST compensation cess to ensure compliance and manage their tax commitments efficiently. Businesses can avail input tax credit (ITC) on inputs, capital goods and services that are used in the business. This credit can be used to offset GST liabilities, including GST compensation. This reduces their tax burden considerably.  Exporters can claim ITC on the cess they pay on inward supplies  relating to the goods exported.

GST compensation cess calculation

GST compensation cess is calculated on the transaction value, that is, the price at which the goods are sold. It is levied in addition to the GST taxes (CGST + SGST) in case of intrastate supplies and IGST in case of interstate supplies.

Step 1: Determine the applicable rate

Select the GST compensation cess rate for the goods and services as specified in GST.

Step 2: Calculate the taxable value

Find out the taxable value of the supplies and services subject to GST compensation cess. That is the selling price of good or services before applying GST.

Step 3: Compute the cess amount

To calculate the cess value, you must multiply the taxable amount by the applicable GST compensation cess rate.

Example

If the taxable value of a particular goods or service is INR 1000, GST rate is 18%, and GST compensation cess of 10% is applicable, then: GST = INR 180; GST compensation cess = INR 100

Step 4: Remit the cess amount

The taxpayer must remit the cess amount along with the GST to the government within the stipulated time frame as per the GST regulations.

Step 5: Record maintenance

Accurate records of the GST compensation cess calculation, payments and documents must be maintained for audit and compliance purposes.

Cess on Income Tax

The health and education cess of 4% was implemented in 2018 to help take care of the education and healthcare needs of people below the poverty line and rural people. Initially, the government intended to provide primary education, it soon realized the importance of secondary and higher education too. So the government introduced an additional secondary and higher education cess of 1%. So the new cess, named the health and education cess of 4%, was introduced. It replaced the education cess of 3% hitherto in practice. This cess is levied on direct taxes like the income tax. Let us understand the calculation of the health and education cess with an example: Mr. A’s taxable income in 2021-2022 is INR 7,00,000/- Income tax is INR 42500/- Surcharge-0 Health and education cess= INR 1700/- Total tax liability= 42500 + 1700 = INR 44200/- The education cess is utilized to fund the education programs and schemes for children from rural and below poverty line families in the country. The funds are earmarked for the following expenses:

• Provide financial support to government aided schools
• Provide students with mid-day meals
• To pay salaries to the staff of government schools and colleges
• To finance special schemes to make education accessible for children
• To fund in the expansion of educational institutions through the country

Conclusion

Cess, if levied and utilized in the right way, can bring transparency and accountability, which in turn can enhance tax compliance. But if the specific purpose for which the cess is levied is not clearly defined, and when  the funds are diverted to other avenues not specified in the purpose for which it is drawn, it defeats the true spirit for which the cess is collected. Good governance with transparent usage of cess proceeds can build credibility of the tax system and increase voluntary compliance. The government must create separate funds within the CFI for the cess revenue collected with separate accounting codes so that they can trace the usage of funds.  The disbursement and expenditure of the proceeds of cess must be made in a transparent and timely manner with suitable accountability measures. Indefinite rollover of cesses should be avoided, and proper audits of cesses should be conducted regularly. Further, audit reports must be published for taxpayers to view. This will increase the trust and confidence of the taxpayers to a great extent and help improve tax contribution.

Frequently asked questions

1. What is cess in India?

Answer: An earmarked tax that is collected and spent for a specific purpose is called a cess in India.

2. How is a cess created?

Answer: A cess can be created and collected only after legislation is framed and passed in the Parliament in India.

3. What is the difference between a tax and a cess?

Answer: Tax is levied on the taxable income, profits of business, cost of goods and services supplied, etc., while cess is a tax on tax, calculated as a percentage of the tax liability of the taxpayer. It is not shared with the state governments but used specifically for the purpose for which it has been created. The revenue received from taxes goes to the consolidated fund of India, while the cess is first credited to the CFI, then transferred to specific programs or initiatives mandated during its creation.

4. What is the impact of cess on the taxpayer in India?

Answer: Cess increases the overall tax liability of the taxpayer. Apart from the tax amount, the taxpayer must pay a little more as cess. Since the cess revenue is utilized for special purposes, it is a social obligation for the taxpayer to fulfill.

5. Who must pay the education cess?

Answer: Education cess is applicable to income tax, but it is not applicable to other types of taxes like GST or customs duty.